On May 13, 2009 FINRA released Notice to Members (NTM) 09-23 as approved by the SEC in Release No. 34-59916. This NTM adopts two changes which affect the way registered broker-dealers and their representatives disclose information.
The revised Forms U-4 and U-5 will be implemented in the Central Registration Depository (CRD) system May 18, 2009, with the exception of the “regulatory action” disclosures (see below) which become effective November 14, 2009. The amendments to Rule 8312 become effective May 18, 2009.
Registered representatives are currently required to report a variety of disciplinary and other actions on the “DRP Page” of Form U-4 and to keep their broker-dealer current within 30 days of the event as to any new or updated developments. See Article V Section 2, FINRA By-Laws. Broker-dealers are required to report to FINRA certain kinds of disciplinary actions and, as well, to forward copies of the underlying materials. Information as to the reasons why a representative has left the firm must be set forth by the firm in Form U-5 and similarly updated. All this information resides on the Central Registration Depository (CRD) electronically maintained by FINRA, where it can be viewed by broker-dealers. Rule 8312 allows the public to have access to some but not all of this information.
NTM 09-23 provides increased disclosure requirements. These, in turn, impose increased liability exposure to broker-dealers and representatives. As well, there is increased exposure to broker-dealers from claims associated with what is reported on Form U-5.
Newly required disclosures as to “regulatory actions” will require broker-dealers to circularize their representatives and go back and review Forms U-4 and U-5 already on file to amend those forms as needed. The new requirements also broaden required disclosures of arbitrations and civil litigation involving persons not named in the complaint but named or identified in the body of the complaint.
Changes to Forms U-4 and U-5
Regulatory Actions. NTM 09-23 amends Forms U-4 and U-5 to add questions requiring disclosure of willful violations resulting in SEC or Commodity Futures Trading Commission (CFTC) regulatory actions and to make it easier to identify persons who are subject to a “statutory disqualification” requiring additional regulatory review. A “statutory disqualification” includes a willful violation of the federal securities laws, the Commodity Exchange Act, or the rules of the Municipal Securities Rulemaking Board. Broker-dealers must amend all the existing Form U-4s of their registered personnel to reflect any such “regulatory actions.” This must be completed by November 14, 2009. In the interim, broker-dealers are bidden to answer “no” to the new questions appearing on May 18, 2009 CRD version of Form U-4. The answer boxes to the new questions are now “blank” and broker-dealers must now immediately go into the system and affirmatively answer “no” on an interim basis. Failure to answer will be a violation. There is a “blanket answer” protocol available, but only during the 180-day period. Failure to amend “no” to “yes” by November 14, 2009 for a particular representative will constitute a statement by the broker-dealer that “no” is the correct answer for that representative. A “yes” answer will require a detailed explanation.
Arbitrations and Civil Litigation. Forms U-4 and U-5 currently require a report as to any arbitration or other civil litigation that names the representative as a party involved in one or more “sales practice violations.” FINRA has revised the forms to require a “sales practice violation” complaint to be reported as well if either (a) the representative was either named or could “reasonably be identified” in a civil lawsuit or arbitration even if the representative was not named as a party or (b) the broker-dealer has made a “good faith determination” that the representative as “involved” in the alleged violation. The representative will have an opportunity to comment in the Form. This change is being implemented only prospectively.
Increase in Minimum Threshold. Forms U4 and U5 currently require reporting of settlements of consumer-initiated litigation and arbitration only if they are in excess of $10,000. FINRA has increased this limit to $15,000. A conforming change is made in the Rule 8312 disclosures.
Termination Date and Changes. There has evidently been confusion with persons serving in several different capacities. FINRA now requires that the “date of termination” listed on the Form is the “date the firm terminated the individual’s association with the firm in a capacity for which registration is required.”
‘Broker Check’ Rule
In 1988 the NASD (now FINRA) adopted Rule 8312, governing the types of information on registered representatives that could be accessed by the public through the CRD system. Currently, the CRD system does not release any information about any person who has not been “associated” with the broker-dealer for two years. FINRA now has made all the additional disclosures described above available for public scrutiny. The current Rule 8312 does not require the release of any information about any representative beyond two years after the representative has ceased to be registered with the broker-dealer. NTM 09-23 now allows disclosure of “final regulatory action” against a person even if that person has not been associated with the broker-dealer for two years. This would include any final action by, essentially, any regulatory agency that would be required to be disclosed on Form U-4 or U-5.
Consequences
These changes are presented by FINRA as an attempt to enable regulators to more easily identify persons subject to statutory disqualification and to broaden the ambit of inquiry into “red flag” activities requiring heightened supervision by the broker-dealer. In the first instance, broker-dealers are now going to need to revise and re-issue the representative questionnaires they use to identify any U-4 disclosable items. They are also burdening broker-dealers with the task of having to use the results of these revised questionnaires to go back and check the U-4s and U-5s of all present and past representatives. And there are “grey areas.” What is a “sales practice violation?” Does it extend, for example, to performance reporting? Most troublesome of all: a broker-dealer is now required independently to amend the U-4 of a registered representative not named in any complaint if a “reasonable investigation” discloses that this representative was “involved” in the violation. For example, if broker X is named in a complaint as a defendant and broker Y is not named as a defendant or otherwise but is his or her supervisor, is broker Y “involved” in the “sales practice violation”? And what happens if broker X is found liable and broker Y is exonerated? Broker Y’s record still stands, cannot be expunged without a proceeding and is subject to public scrutiny while he/she is still registered with that broker-dealer and for at least two years thereafter.
More troublesome is the continuing nagging question of broker-dealer liability to representatives for alleged “defamatory” statements on Form U-5. This potential liability is not reduced by the FINRA proposals, which increase the uncertainty about the duty to report and increase the level of pubic access to information about representatives. True, the U.S. Court of Appeals for the Second Circuit did rule in 2007 that a broker-dealer has “absolute immunity” from defamation suits in Rosenberg v MetLife, Inc. et al, ( 2d Cir, October 21, 2007), No. 05-4363-CV. But there is no guarantee that another Federal Circuit would not rule the other way. And arbitrations since then have allowed damages to “defamed” representatives. The imposition of more disclosure obligations on broker-dealers, particularly in these “grey areas,” can only add to the headache of trying to comply.
All this seems to add up to an increased level of vigilance on the part of licensing and compliance personnel.
Geoffrey T. Chalmers, Esq. is a Boston-based securities attorney and compliance professional who contributes to the Regulatory Compliance newsletter from time to time on legal and compliance topics.
Back to top
Back to Newsletter
|
